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On October 23 and 24, the Internal Revenue Service (IRS) and the
Department of Labor (DOL) issued coordinated guidance on lifetime income
provided through target date funds held by retirement plans. According to an
accompanying press release from the Treasury and, like the final regulations on
longevity contracts issued in July 2014, the guidance is intended to encourage
and expand the availability of retirement income options in defined
contribution plans. It thus continues the pattern of resolving regulatory
uncertainties that can impede the utilization of these options in 401(k) and
other plans.

The guidance considers a retirement plan investment option
structured as a series of target date funds (TDFs) that may buy, as part of
their fixed income allocation, deferred income annuity contracts providing
specified amounts of lifetime or periodic income commencing (usually) in the
future. Each TDF is available to participants of a specific age or in an age
band, in part because the price of the future annuity income actuarially varies
with the age of the participants. The
investment manager manages each age-restricted TDF to become more conservative
as the age of the participant cohort advances, which may increase the
allocation to the annuity. The annuities are distributed to the participants at
the target date.

IRS Notice 2014-66

In Notice 2014-66, the IRS considered the permissibility of this
structure under the I.R.C. §401(a)(4) nondiscrimination requirement for
qualified retirement plans, and specifically the rules that:

Benefits, rights and features under the plan must be currently available
to a nondiscriminatory classification of employees, and

The
group of employees to whom benefits, rights and features are effectively
available must not substantially favor highly compensated employees.Age-restricted TDFs at older ages could disproportionately be
available to highly compensated employees because older employees often tend to
be more highly paid than younger employees. As a tax policy matter, however,
the regulations under I.R.C. §401(a)(4) specifically allow social security
supplements and optional forms of benefits that include age restrictions.
Noting those tax policy judgments, the IRS exercised its authority under the
regulations to publish in the Notice a special rule that a series of
age-restricted TDFs would be treated as a single "right or feature"
for these purposes, thus avoiding the need for each TDF to qualify separately,
if:

The
series of TDFs is designed to serve as a single, integrated investment program
managed by the same manager applying the same generally accepted investment
theories, with the result that the only difference among the TDFs is the mix of
assets selected for the level of risk appropriate at each age band.

Each
TDF is treated in the same manner with respect to rights and features – e.g.,
the manner in which fees and administrative expenses are determined and paid –
other than the mix of assets.

Sutherland Comment: These two conditions appear intended to ensure
that the TDFs are not otherwise treating older and younger participants in a
discriminatory manner. For example, the Notice requires that the fee structure,
including any portion paid by the plan sponsor, be determined in a consistent
manner among the TDFs. The Notice presumably is not intended to require that
the TDF glide path manager, the manager of the equity sleeve and the manager
of the fixed income sleeve are all the same entity, but only that each of
those separate functions is consistently carried out by a single entity.

Some
of the TDFs available at older ages include deferred annuities that do not
provide guaranteed lifetime withdrawal benefits or guaranteed minimum
withdrawal benefits (GLWBs or GMWBs).

The
TDFs do not hold employer securities as described in Employment Retirement
Income Security Act (ERISA) §407(d)(1) unless they are readily tradable on an
established securities exchange.

Sutherland Comment: Other than with respect to GLWBs and GMWBs, about
which the Treasury is still considering guidance, and employer securities,
presumably to avoid familiar issues when plans hold untraded employer securities,
the Notice does not appear prescriptive with respect to the form of the
annuities or the TDFs, which would need to comport with applicable ERISA,
banking, insurance, securities or other requirements. The tax guidance
contemplates that the TDFs may be either a default or a regular investment
option under the plan.

DOL Information Letter

In an information letter dated October 23, DOL confirmed that a
properly structured TDF that includes a deferred

annuity will be a qualified
default investment alternative (QDIA) and that a responsible plan fiduciary who
prudently appoints the TDF investment manager will generally not be liable for
the manager's selection of an annuity provider.

Under
the QDIA rules, the plan fiduciary responsible for plan investments is liable
as an ERISA fiduciary for the selection of the QDIA but not for the
consequences of the participant's investment in the QDIA by default. So long as
the TDF otherwise meets the QDIA requirements – including a more conservative
investment allocation among fixed income and equities as the target date
approaches, specified notice to participants, unrestricted transferability
during the first 90 days and quarterly transferability thereafter subject to
fees, if any, that do not difference between investment by default or
affirmative direction – DOL confirmed that, pursuant to its regulations,
neither the presence of unallocated annuity contracts in the TDFs nor the
distribution of the annuities at the target date would cause the TDF to fail to
be a QDIA.

DOL
also confirmed that, under the usual rules for the allocation of ERISA
fiduciary responsibility, the responsible plan fiduciary is responsible for
selecting and monitoring a §3(38) investment manager, but that manager is
responsible for its investment decisions including the selection of the annuity
provider pursuant to DOL's optional safe harbor for such selections in defined
contribution plans or otherwise.

Sutherland Comment: The information letter specifically addresses
"unallocated" annuity contracts – i.e., contracts held for the TDF
without allocation to individual participants – and the Notice in an example
contains a similar reference. Thus, it is clear that allocation in the
contracts of specific annuity benefits to specific participants is not
necessary to the results in the guidance.
We see no reason why properly structured allocated contracts should be
treated differently than unallocated contracts for these purposes.

Sutherland assisted in requesting this guidance.

For more information, in the Tax Management Portfolios, see
Horahan and Hennessy, 365 T.M., ERISA — Fiduciary Responsibility and
Prohibited Transactions, and in Tax
Practice Series, see ¶5530, Fiduciary Duties and Prohibited Transactions.

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